Carrier Reports Robust 2Q20 Results; Maintain Hold Rating

On July 30, 2020, Carrier Global Corporation CARR (NYSE: CARR, $28.97, Market capitalization: $25.1 billion), leading global provider of HVAC, refrigeration, fire, security, and building automation technologies, reported 2Q20 results with an overall beat versus consensus on both EPS and revenue. In 2Q20, the company recorded sales of $4 billion, down 20% YoY (19% on an organic basis) as compared to $5 billion in the 2Q19. The decline in sales reflects the impact of the COVID-19 pandemic across all businesses. In 2Q20, operating profit was $442 million, down 45.1% YoY, as compared to $805 million in 2Q19, while adjusted operating profit was $476 million, down 41.5% YoY, with an adjusted operating margin declining by 440 bps to 12.0%. Carrier’s 2Q results reflected aggressive cost actions, better-than-expected end-market demand benefiting from warmer weather, and improving order trends across its three business segments. Adjusted EPS declined 54.8% YoY to $0.33 per share, as compared to $0.73 in 2Q19.

The company has updated its full-year outlook to reflect the anticipated impacts of the COVID-19 pandemic. Carrier increased its lower end of sales guidance and now expects FY20 sales to be at $15.5 billion to $17 billion (previous guidance of $15-17 billion). The company expects high single-digit EPS growth in the medium-term outlook. In June 2020, the company declared a quarterly dividend of $0.08 per share, which was paid on July 20, 2020, to shareholders of record at the close of business on June 26, 2020.

Valuation and Recommendation

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We value Carrier at $30.00 (Previously:$20.00) per share based on 2021e EV/ EBITDA multiple of 13.5x. Our valuation factors in the company’s better than expected performance in the second quarter despite the COVID-19 situation and revised guidance for the rest of 2020. We retain our ‘Hold’ rating on the stock with an implied upside of 3.6% from the current market price of $28.97 as on 8/7. Risks to our Target Price include extended COVID-19 overhang, cyclical economic downturn beyond 2020, leading to a slowdown in the residential replacement cycle.

FY20 Outlook

For FY20, Carrier expects sales to be at $15.5 billion to $17 billion (previous guidance of $15-17 billion), given the more robust demand in June, especially in the Americas. Adjusted operating profit is expected to be in the range of $1.8 billion to $2.0 billion (previous guidance of $1.7- 2 billion), and Free cash flow in excess of $1.1 billion (prior guidance of $1.0 billion). The company has not provided EPS guidance; however, it expects high single-digit EPS growth in the medium-term outlook. Capital spending is now expected to be in the $250 million to $275 million range compared to the prior $200 million to $225 million as the company invests for future growth.

Other Business Updates

The company has accelerated and increased savings through Carrier 600, which is the company’s plan to eliminate $600 million in cost over three years. The program initially targeted $175 million of savings in 2020. After the first quarter, the company increased its full-year tracking from $225 million and now is targeting $250 million of recurring in annual savings. The company also announced one-time cost actions of $300 million. The company is currently on track to deliver $115 million of cost savings in the second quarter.

Carrier has renegotiated its term loan and $2 billion revolver (currently undrawn) debt covenants, raising its maximum leverage ratio to 4.75x (versus earlier 4.0x), facilitating the issuance of an additional $750 million term loan in June 2020 (with the earliest maturity in 2023). Due to stronger free cash fl ow generation during 2Q and the capital raise, the company now has much better liquidity, with a cash position of $2.7 billion as of June 30, 2020 (versus roughly $800 million as of March 31, 2020).

In 2Q20, sales declined 20% YoY to $4 billion as compared to $5 billion in the 2Q19. The decline was attributed to a 19% decline in organic sales and a 1% impact from foreign exchange. The decline in sales was primarily due to the impact from the COVID-19 pandemic across all businesses. In 2Q20, Operating Profit was $442 million, down 45.1% YoY, as compared to $805 million in 2Q19, with margin contraction of 510 bps to 11.1%. Adjusted Operating Profit for 2Q20 was $476 million, down 41.5% YoY, with a margin contraction of 440 bps to 12%. The adjusted operating profit was positively impacted due to Carrier’s aggressive cost containment and the acceleration of the Carrier 600 program. Net income in 2Q20 was $261 million, down 66.7% YoY, and included $25 million of net nonrecurring and restructuring charges. Adjusted Net Income was $286 million, down 54.2% YoY, as compared to $625 million, in the prior-year period. In 2Q20, diluted EPS was $0.30, down 67% YoY, as compared to $0.91 in the 2Q19, while adjusted diluted EPS was $0.33 per share, down 54.8% YoY as compared to $0.73 in 2Q19 after excluding net nonrecurring and restructuring charges.

In 1H20, sales dropped 15.3% YoY to $7.9 billion as compared to $9.3 billion in the prior-year period. The decline was attributed to a 14% decline in organic sales and a 1% FX impact. In 1H20, Operating Profit was $757 million, down 42% YoY, with margin contraction of 440 bps to 9.6%. Adjusted Operating Profit for 1H20 was $912 million, down 31.6% YoY, with margin contraction of 280 bps to 11.6%. Net income in 1H20 was $357 million, down 69.8% YoY, while Adjusted Net Income was $592 million, down 43% YoY. Diluted EPS for the first half was $0.41 per share, down 70.1% YoY, as compared to $1.37 per share in the prior-year period, while adjusted diluted EPS for the first half was $0.68 per share, down 43.8% YoY, as compared $1.21 in 1H19.

Segmental Information

HVAC (Heating, Ventilating and Air Conditioning)

In 2Q20, HVAC segment sales were $2.3 billion, down 16.2% YoY, as compared to $2.7 billion in 2Q19. The organic sales declined 15% due to a 17% decline in commercial HVAC and a 13% decline in residential HVAC, primarily driven by the economic slowdowns related to the COVID-19 pandemic. In 2Q20, operating profit was $358 million, down 34.3% YoY, while adjusted operating profit declined to $359 million down 33.8% YoY. Operating profit margin declined 430 bps to 15.6%, while the adjusted operating profit margin declined 410 bps to 15.7%, as compared to 19.8% in 2Q19. The operational decrease was primarily attributable to lower sales volumes and unfavorable mix, lower income from equity method investments as a result of economic slowdown related to the COVID-19 pandemic, and the unfavorable impact of a change in the estimate of certain long-term liabilities. For 1H20, sales were $4.2 billion, down 13.3% YoY, as compared to $4.9 billion in the prior year, with a 13% decline in organic sales. Operating profit declined to $525 million (down 37.4% YoY), and margin contracted 470 bps, while adjusted operating profit declined to $601 million (down 28.4% YoY), and margin contracted 300 basis point as compared to 1H19.

Refrigeration

In 2Q20, the Refrigeration segment sales were $700 million, down 26.7% YoY, as compared to $955 million in 2Q19. The organic sales declined 25% due to a decline in transport refrigeration and commercial refrigeration, primarily due to the COVID-19 pandemic. In 2Q20, operating profit was $61 million, down 49.6% YoY, while adjusted operating profit declined to $64 million, down 48.8% YoY. Operating profit margin declined 400 bps to 8.7%, while the adjusted operating profit margin declined 390 bps to 9.1%, as compared to 13.1% in 2Q19. The operational profit decrease was primarily attributed to lower sales volumes and unfavorable mix that was partially offset by the benefit of favorable material productivity and cost containment initiatives. For 1H20, sales were $1.5 billion, down 21.3% YoY, as compared to $1.9 billion in the prior year, with a 19% decline in organic sales. Operating profit declined to $160 million (down 35.5% YoY), and margin contracted 230 basis points, while adjusted operating profit declined to $163 million (down 36.1% YoY), and margin contracted 250 basis points as compared to 1H19.

Fire & Security

In 2Q20, Fire & Security segment sales were $1.1 billion, down 23.7% YoY, as compared to $1.4 billion in 2Q19. The organic sales declined 22% due to lower product and field service sales, primarily driven by lower volume in North America and Europe due to the COVID-19 pandemic. In 2Q20, operating profit was $106 million, down 42.4% YoY, while adjusted operating profit declined to $112 million, down 41.7% YoY. Operating profit margin declined 320 bps to 10.0%, while the adjusted operating profit margin declined 330 bps to 10.6%, as compared to 13.9% in 2Q19. The operational profit decline was primarily attributed to lower sales volumes and unfavorable mix as well as higher reserves for customer credit losses. These decreases were partially offset by favorable material productivity and cost containment initiatives. For 1H20, sales were $2.3 billion, down 15.4% YoY, as compared to $2.7 billion in the prior-year period, with a 14% decline in organic sales. Operating profit declined to $226 million (down 28.5% YoY), and margin contracted 180 basis points, while adjusted operating profit declined to $238 million (down 29.4% YoY), and margin contracted 210 basis points as compared to 1H19.

Valuation

Carrier Global Corporation:

Carrier business provides heating, ventilating, air conditioning (HVAC), refrigeration, fire, security, and building automation products, solutions, and services for residential, commercial, industrial, and transportation applications. Carrier’s future growth strategy has three key components: growing its installed base by investing in new product R&D; expand geographically and with product line extensions (such as Variable Refrigerated Flow), and expand the aftermarket services business.

EV/EBITDA Valuation: We value Carrier at $30.00 (Previously: $20.00) per share by applying 2021e EV/EBITDA multiple of 13.5x. The assigned multiple is at a ~11% discount to its median peer multiple of 15.2x. The stock has seen material multiple expansion in line with its peers and is now trading at a fair valuation level relative to its fundamentals. The trading discount to peers to be appropriate given Carrier’s limited financial flexibility and significantly higher comparative leverage profile. Our valuation factors in the company’s better than -expected performance in the second quarter despite the COVID-19 situation and revised guidance for the rest of 2020. We retain our ‘Hold’ rating on the stock with an implied upside of 3.6% from the current market price of $28.97 as on 8/7. Risks to our Target Price include extended COVID 19 overhang, cyclical economic downturn beyond 2020 leading to a slowdown in a residential replacement cycle.

Company Description

Carrier Global Corporation

Carrier is a leading global provider of innovative HVAC, refrigeration, fire, security, and building automation technologies. Supported by the iconic Carrier name, the company’s portfolio includes industry-leading brands such as Automated Logic, Carrier Transicold, Edwards, GST, Kidde, LenelS2 and Marioff. Carrier’s businesses enable modern life, delivering efficiency, safety, security, comfort, productivity and sustainability across a wide range of residential, commercial and industrial applications. Carrier has an extensive global footprint with approximately 53,000 employees globally, including over approximately 3,600 engineers, and its solutions are sold in over 160 countries around the world. Carrier recorded sales of $18.6 billion in FY19.

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